A collection of best practice articles to help grow companies with an emphasis on finance. The goal of the blog is to explain how these best practices work, enabling anyone to put these ideas to immediate use. Articles are written by Matt H. Evans, CPA, CMA, CFM

Upcoming Articles

NOTE: Effective January 1, 2017, I will no longer post new articles since I am now fully retired.

Wednesday, April 6, 2016

Do You Know Your Algorithms

If you want
to drill down to the root cause behind what drives so much value in today’s
world, then you need to know your algorithms. An algorithm is a set of
instructions that processes inputs and provides some output. Companies that
master their algorithms unleash incredible value. Take for example Uber which
relies on algorithms to locate available drivers for customers, processes locations
and times, and then delivers online progress and statistics of the ride. When
you couple algorithms with great design, then you have a value proposition that
others will want. Therefore, getting your algorithms right has profound
implications on your business.

One of the
reasons algorithms are so powerful is that they help predict things in advance.
This is usually accomplished by running a series of ‘if then’ statements to
discern patterns. For example, algorithms tell Home Depot and Lowes which inventory
items to stock and how much according to weather forecasts. When a hurricane is
expected to make landfall, algorithms measure the intensity and size of the
storm, match the target location in terms of population and other demographics
and turn out forecasted inventory requirements so every store can maximize meeting
future demand.

One popular
type of algorithm is the pricing algorithm. These algorithms alter and change
prices according to existing capacity and demand. Airlines use these algorithms
to maximize revenues for open seats on planes. This same approach is used by
other companies who can only produce so much, but want to place and sell their limited
products at the right time and place for maximum revenues.

Every
company that operates on the internet is run by algorithms. For example, when
you visit Amazon and review a product, other similar type products show up
giving you alternative choices. Amazon uses algorithms to display the types of
products you are likely to buy, generating more sales. According to i2
Technologies, a company that develops algorithms, their clients will save $ 75
billion through the use of algorithms over the next ten years.

“Algorithms increasingly run our lives. They
find books, movies, jobs, and dates for us, manage our investments, and
discover new drugs. More and more, these algorithms work by learning from the
trails of data we leave in our newly digital world. Like curious children, they
observe us, imitate, and experiment. And in the world’s top research labs and
universities, the race is on to invent the ultimate learning algorithm: one
capable of discovering any knowledge from data, and doing anything we want,
before we even ask.” - The Master Algorithm: How the Quest for the Ultimate
Learning Machine Will Remake Our World by Pedro Domingos

Most of us
know nothing about algorithms. They operate in the background of our lives,
impacting everything. Execution algorithms are used by large brokers (such as
Goldman Sachs) to re-allocate money using TWAP (time weighted average pricing)
and VWAP (volume weighted average pricing) algorithms. Behavioral algorithms
figure out the rules of competing companies and exploit the behavior in order
to realize a profit. Algorithms are critical for sorting, searching, parsing
and working through mounds of data for optimal solutions. The world’s financial
markets, including stock exchanges, pension funds, and banking transactions are
largely run by algorithms that access and interpret personal data.

“The single greatest instrument of change in
today’s business world, and the one that is creating major uncertainties for an
ever-growing universe of companies, is the advancement of mathematical
algorithms and their related sophisticated software. Never before has so much
artificial mental power been available to so many—power to deconstruct and
predict patterns and changes in everything from consumer behavior to the
maintenance requirements and operating lifetimes of industrial machinery. In
combination with other technological factors—including broadband mobility,
sensors, and vastly increased data-crunching capacity—algorithms are
dramatically changing both the structure of the global economy and the nature
of business.” - The Algorithmic CEO by Ram Charan, Fortune Magazine

Algorithms
are not without issues. Take for example how the European Union has challenged
Google that its search engine algorithms are a violation of anti-trust laws.
Results from the algorithms allegedly show a bias in favor of products and
services provided by Google. And because algorithms are not subject to
independent scrutiny, any errors in the logic or data can inflict major errors
that no-one detects. Increasingly, everything we do is influenced by algorithms
and given the fact that so much of your business is riding on the integrity of
your algorithms, it begs a simple question – Do you know your algorithms?